Are Mutual Funds Safe?

Are mutual funds safe? No it is not! Mutual funds are subjected to all investment risks that your underlying investment asset class is subject to and many more.

Going back to the fundamental investing rule - High Risk = High Return; Low Risk = Low Return. Your returns are the rewards for managing the risk of an asset class. So if you are earning any kind of return from your mutual funds (which in most cases you are), there is a risk associated with them.

The question should not be: Are Mutual Funds safe? Which are the safest Mutual Funds? You must understand the underlying risk of these mutual funds and invest in them based on your risk taking capacity. 

How to Check the Risk of Investing in Mutual Funds? 

Riskomter in fact sheet  - As per SEBI's product-labelling guidelines, AMCs have started disclosing the new riskometers for their funds. The five risk levels are ‘low’, ‘moderately low’, ‘moderate’, ‘moderately high’ and ‘high’. This helps investors get a better picture of the right risks associated with a particular fund. You must check the riskometer to get a brief idea of the risk of the particular mutual fund scheme.

Standard deviation - A fund's standard deviation tells you how volatile or risky a fund can be compared to the benchmark and its peers.

When prices move wildly, standard deviation is high, meaning an investment will be risky. Low standard deviation means prices are calm, so investments come with low risk. Instead of just looking at the standard deviation of a fund, you should compare the standard deviation of a fund with the standard deviation of the benchmark index to get a better idea of the risk

When it comes to Debt Mutual Funds, there are some specific factors that one can check to know the underlying risk of the same i.e.

1. Credibility of the fund

Debt Mutual Funds can invest in securities with different credit ratings, as per the scheme's investment strategy. The credit rating of the security is listed alongside its name in the mutual fund factsheet. These ratings are assigned by different rating agencies and indicate the credit worthiness of the borrower. Higher the rating, higher is the creditworthiness of the borrower, although the returns may be lower as compared to a bond issued by an entity that has a lower rating.

2. Duration of the fund

SEBI has defined categories of mutual funds based on maturity or Macaulay duration of the fund. Put very simply, Macaulay Duration is the time taken for a bond to repay its own purchase price in present value terms. Generally, the longer the maturity of the instruments that the mutual fund holds, the higher the Macaulay duration of the fund. Typically the longer the maturity/duration of the fund, the higher the expected returns. But higher duration also leads to higher volatility in returns with change in interest rates.

Simply put, ultra short duration funds, liquid mutual funds being the one with the shortest duration and underlying better credit securities (you must check the portfolio before investing) are the safe debt mutual funds to invest in. That is why we generally recommend these for any short term goals and emergency fund needs of our investors. 

You can learn more about the underlying risk of Investing in Equity - here and Investing in Debt - here

Wealth Café Advice: 

As explained above, mutual funds are not safe, there will always be a certain level of risk in them. You must analyze that risk based on your risk taking capacity and invest only in those funds which you understand and are okay to bear/manage the risk to achieve your goals. Do not invest in small cap funds or thematic funds because they are trending and you are a conservative person. The funds will trend while you will have sleepless nights. You can’t entirely escape risk, but you can always manage it.  Understanding your risk capacity is the very first key step to help investors gain without pain. -What is a Risk profile? How to Invest basis that?

 

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

 

 

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision

 

Investments / Mutual Funds - 12/02/2021

Pay taxes on Mutual funds - Unrealized vs Realized Gains

Whether you are putting money away for a rainy day, retirement or anything in between, you are likely to be taxed. Investors do not think about tax expenses when making investment decisions, even though it is one of the crucial aspects of investing.

Do you check pre tax and post tax returns before you invest your money ? Do you know how fixed deposits and debt mutual funds investments can impact your tax differently? Let's discuss how the difference in taxability of Debt Mutual Funds versus Fixed deposits becomes one of the factors you must consider when you make an investment decision.

Difference between realized and unrealized gains in a mutual fund.

Realized gains are the returns you make after actually redeeming(selling) your mutual funds. Unrealized or notional gains or losses are the ones which you see based on everyday market movements but do not book it. Unrealized gains only exist on paper and results from an investment which has yet not been sold.

Taxation of gains

Where there are unrealized gains - no tax is payable as you have not booked any profits. Only in case of realized gains, do you have to pay taxes in case of a mutual fund. So once you sell your Mutual funds and the funds are credited to your bank account, you have to compute your tax liability and pay capital gains taxes on the same.

To know more about the taxability of mutual funds, check here - Taxation of Mutual Funds for FY 2021-22 (AY 2022-23).

It is not that every other asset class, you pay taxes on actual basis, in fact in a fixed deposit, you pay taxes on interest accrued to you, even where the same is not credited to your bank account each year. This way Fixed deposit income is taxed differently as compared to debt mutual funds (because the gains are taxed only on realisation) 

Let's take an example to help you explain how tax eats into your profits.

For the purpose of this example, we shall consider that the returns from fixed deposits and debt mutual funds are the same. They will be taxed as per the relevant tax laws and how that would impact the net returns you can make from the investment. 

Ria is the investor and she falls under the 20% tax bracket. She has made an investment of INR 10 lakhs in FD and debt mutual funds for 3 years, giving a return of 8% per annum.

https://financial.wealthcafe.in/blog/2021/06/cost-of-inflation-index-fy-2021-22-ay-2022-23-for-capital-gain/

In case of FD, interest will accrue to her every year, and she has to pay taxes on the same as per her slab rate every year, even where the same is not credited to her bank account. Infact, the interest after the taxes are paid will be reinvested.

FD = INR 10,00,000

Interest - INR 80,000

Tax - 16,000

Reinvestment of Interest in year 1 = 64,000

(same reinvestment would happen in year 2 and year 3 - after tax)

After 3 years: 

Total tax paid - INR 48,000

Net cash in hand = INR 12,04,288

 

In case of debt mutual funds, she will have to pay taxes only on realization of profits. She decided to sell the same after 3 years and will have to pay long term capital gains on the same at 20% (with indexation benefits). So effectively, the tax she has to pay is less than what she had to pay for her fixed deposits. Also, the reinvestments would be of the entire earnings and not just post tax earnings in case of fixed deposits.

Amount invested - INR 10,00,000

Gains = INR 80,000

Tax - Nil (No sale)

Reinvestment of gains = INR 80,000*

After 3 years

Total Tax Paid - INR 32,565 (indexation benefit)

Net cash in hand - INR 12,27,147

*the returns are not assured in a debt mutual fund. We have considered this for explanation purposes here.

 

From the above example, you can understand that the net cash in hand that ria would earn is 102% of the final amount from fixed deposits. Infact, if she was in the 30% tax bracket, she would make 104% more in the case of debt mutual funds than fixed deposits.

This is how realized and unrealized gains impact your tax in various asset classes and also become one of the factors that one must consider when they are investing their money.

You can also check our blog on -Why you should avoid investing all your money in a FIXED DEPOSIT?

 

Wealth Café advice: 

Please note that tax is not the only but one of the criteria that one must look at when investing their money in debt funds and Fixed deposits. Fixed deposits are safer and provide assured returns as compared to debt mutual funds. Debt mutual funds have many types and each has a different risk parameter. You can look at the liquid funds, or ultra short duration debt funds for lower risk and comparable returns to Fixed deposits. Please note that returns in all debt mutual funds are volatile and invest in them only after considering all the possible risks.

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

 

 

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

Investments / Mutual Funds / Tax - 12/01/2021

What are the fees you pay on your mutual funds? - fees on the fund is charged and NAV is after that

There are many different investment options available to help you reach your financial goals. Regardless of which investment you choose, it is important to understand the costs involved and how they can affect your investment. 

What are these charges??

When you go out to eat pizza, are you charged only for the ingredients that were used to make the pizza? Of course not. The bill you pay includes other  charges incurred by a restaurant including its rent, electricity, etc. as well as the chef’s expertise. Similarly, when you buy a mutual fund you do not just pay for the securities  that your fund buys and sells. 

The majority of these expenses are Investment and Advisory fees. Apart from this, there are some other fund management expenses like marketing and selling expenses including agents’ commission, brokerage and transaction cost, registrar fees, trustees fee, audit fee, custodian fees, costs related to investor communication, and more. The total expenses charged by a Mutual Fund are capped in what is called the Total Expense Ratio. 

Total Expense Ratio 

Currently, in India, the expense ratio is fungible, i.e., there is no limit on any particular type of allowed expense as long as the total expense ratio is within the prescribed limit. The regulatory limits of TER that can be incurred/charged to the fund by a Mutual Fund AMC have been specified under Regulation 52 of SEBI Mutual Fund Regulations.

Effective from April 1, 2020 the TER limit has been revised as follows.

Assets Under Management (AUM) Maximum TER as a percentage of daily net assets
TER for Equity funds TER for Debt funds
On the first Rs. 500 crores 2.25% 2.00%
On the next Rs. 250 crores 2.00% 1.75%
On the next Rs. 1,250 crores 1.75% 1.50%
On the next Rs. 3,000 crores 1.60% 1.35%
On the next Rs. 5,000 crores 1.50% 1.25%
On the next Rs. 40,000 crores Total expense ratio reduction of 0.05%for every increase of Rs.5,000 crores of daily net assets or part thereof. Total expense ratio reduction of 0.05%for every increase of Rs.5,000 crores of daily net assets or part thereof.
Above Rs. 50,000 crores 1.05% 0.80%

Source: https://www.amfiindia.com/investor-corner/knowledge-center/Expense-Ratio.html 

How are these charges levied to the investor? Where can I see this charge?

The expenses are deducted from the NAV of your Mutual Fund Scheme on a daily basis. The NAV that is listed every day is published only after deducting expenses of a mutual fund. For example, if your investment value today is Rs. 100,000 and expense ratio of your fund is 1% then today’s expense amount charged to your Fund  will be 100,000 X 1% / 365 i.e. Rs.2.73. The total value of your investments will be reduced to INR 99,997.27. 

Basically, you do not get a separate report of your charges in the account statement but it is deducted from your fund NAV. You can check the expense ratio as a % to know whether the fund you own has a high or low expense ratio compared to other funds. It is one of the factors to refer to but remember that it is not the only one.

Wealth Café advice:

Before investing in a fund, you should always check the expense ratio. If it’s possible, read the Scheme Information Document to see what all expenses have been charged for. Also, remember, a good fund is the one that delivers good performance with optimal expenses.

 

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

Mutual Funds - 11/29/2021

What are the factors you must check when you are looking at a mutual fund?

Are you someone investing in mutual funds using app filters like 4-5 stars or sorting it based on highest to lowest returns? Do you invest in mutual funds with low NAV and believe you bought it for cheap? Do you feel that lower the expense ratio of a mutual fund scheme, cheaper the investment for you? Do you make mutual fund investments based on hearsay or advice from your relatives, colleagues or train companions? Or, are you investing in the Best 2021 Mutual Funds suggested on someone's Instagram reels?

Well, if your answer to any of the above questions is yes, then you are at the right place. Selecting a mutual fund is an art and science that is tough to learn but rewarding in the long run.

FACTORS TO CONSIDER

Personal Needs: Your Individual requirements

  1. Investment Objective - Every investor has an objective, a set of goals behind their investments. We all save and invest money to achieve our goals such as travelling, buying a car, buying a house etc. If nothing, then the basic objective of achieving wealth creation or financial freedom is a must for everyone. So before you start your investment it is important to pen down your goals along with the amount needed for that goal. You can learn more about this on this article here - Goal based investment
  2. Goal Tenure - Once your objective is in place, you need to calculate the time required to achieve that goal. It will also help you to choose the right investment for you. Simply put - short term goals - invest in debt ; long term goals - invest in a mix of debt & equity as per risk profile.
  3. Risk Profile - Now that you know the amount you need and when you need it, the next step is to understand your risk profile i.e. how do you want to reach the amount that you need. You must understand how much risk you are comfortable taking to achieve your goals. A person with an aggressive risk profile has a higher risk taking capacity and can invest, say 80% of his savings, in equity whereas a conservative person would invest a lot less in equities. The idea is that you take only so much risk that allows you to sleep peacefully, invest consistently and have a smooth ride to achieving your goals. Know more about your risk profile and how it helps you invest better in this article - What is a risk profile? How to invest basis that?

Quantitative factors: Evaluating the Fund

1. Past Return Performance

Past performance of a Fund is a starting point of what to expect from investing in a fund. However, ensure that you do not look at this number in isolation.

  • Every mutual fund scheme has a benchmark against which it tracks and evaluates its performance. Check how the mutual fund scheme has performed compared to its benchmark. Has it been under-performing its benchmark or been able to beat the benchmark consistently?
  • You should then check the returns of the mutual fund in comparison to other funds in the same category. If you are choosing a Large cap fund, you must check how well your fund has performed in comparison to other large cap funds.

All this while you must bear in mind that there is no guarantee of the past performance of the fund being repeated in the future.

2. Risk Statistics

Risk is uncertainty and variability in returns. Returns are the result of managing the risk. Some of the statistics that will help you understand the risk your fund is taking to achieve the returns you just analyzed include:.  

  1. Standard Deviation: It measures the mutual funds’ investment risk and is indicative of the stability of returns of a portfolio. With this information, you can judge the range of returns your fund is likely to generate in the future. Higher the standard deviation of a fund, higher is the risk associated with the investment.
  2. Beta: It measures volatility of the fund compared to its benchmark. If the beta of a scheme is more than 1, then the scheme is more volatile than its benchmark. If beta is less than 1, then the scheme is less volatile than the benchmark. Lower the beta, lower the risk associated with the fund. 
  3. Sharpe Ratio: Unlike the previous two measures, the Sharpe Ratio gives you the risk adjusted returns of a portfolio. If two funds have similar returns, the one with the higher standard deviation will have a lower Sharpe Ratio. A fund with a higher Sharpe Ratio is considered better than its peers as it is able to deliver higher risk adjusted returns.

3.  AUM of the Fund

AUM is the total amount invested by that particular fund. It is the total market value of the assets that a mutual fund manages at a given point in time. 

Only because a Fund has a large AUM, it does not mean it is a good Fund. You need to consider other factors as well. Having said that, avoid Mutual Fund Schemes that have a very small AUM as the returns from such schemes can be very volatile and subject to large movements on exit by large investors of that scheme.

4. Cost of the fund:

As with any business, running a mutual fund involves costs. This cost is called the Expense Ratio. If you have 2 identical funds w.r.t. to the above discussed parameters, then you choose the fund with the lower Expense Ratio. Check out our article to understand it more in detail

III. Qualitative factors: Fund Manager and Fund’s philosophy

The fund manager is the professional who takes the investment decisions for your money after you invest in a scheme. The fund manager plays a key role in how your investment performs, as he/she is the person to decide on which stocks or securities to invest and how to distribute the money for a particular mutual fund. 

Obviously the Fund manager is not alone and he has a team helping him do the analysis and his decisions will be based on the Objectives of the particular Scheme and the overall Fund Management philosophy.  

Apart from looking at the qualifications of the Fund Manager, you must look at his experience and how long he has been managing the Mutual Fund Scheme and the performance of the Fund under him. Longer his tenure with the fund with a consistent performance should give you confidence in selecting the Fund.

A strong Mutual Fund team, guided by well defined Investment Fund Philosophy will be a great aid to an experienced Fund Manager.

Wealth Café  Advice: 

These pointers will give you a headstart to start evaluating the various Mutual funds schemes and shortlist them. You need to regularly track these parameters of your invested Funds, track the Fund Managers and see how your Fund is performing vis-à-vis the market. 

If your day to day job does not give you the time to keep a track of your funds, you can always consult an expert whoa will do this for you. If you want us to manage your investment, you can learn more about us at ria.wealthcafe.in and reach out to us.

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

 
Mutual Funds - 11/25/2021

How are investors buying mutual funds - looking at the best performing ones?

The first thing to answer before you start investing is to know “WHY” you are investing in Mutual Funds.

  1. Debt Funds - To build a safety net, achieve short term goals and earn higher tax efficient returns compared to  fixed deposits.
  2. Equity Funds - To create long term wealth and achieve goals

 

Many Investors just look at the best performing funds. They would google - Top 5 funds for 2020 or Top 5 funds for 2021 and invest their money in the fund names that appear. So much so that most of the time they do not even remember the name of the fund. So many times, we have asked people - which fund have you invested in and I would get an answer saying - Umm HDFC bank? Kotak? Something DDFC…basically full confusion and no research.

 

Yes, when you don't know how to invest and you want to invest, choosing the best funds based on recent past performance seems the easiest choice to make. However, it would also turn out to be a bad choice. 

 

Studies have proven that selecting mutual funds based on high-performance track records is naïve. The Star rating of various mutual funds keeps changing, a fund that is top rated in this one year, is hardly the top-rated fund in the subsequent years. Tim Courtney, a chief Investment advisor of US-based Burns Advisory, did backtesting of past performance of the funds most highly rated, he found that they usually performed poorly after they have gotten 5 ratings. Hulbert financial digest, an investment newsletter, found that if investors continually adjusted their mutual funds' holdings to hold only the highest-rated funds, a total stock market index would have beaten them by 45.8 % in the past decade (he studied funds from 1994 to 2004 in the USA). In fact over the years, it has gotten even more difficult to beat the markets and get alpha on your investments.  - extracts from Millionaire extracts - How to build wealth living overseas by Andrew Hallam

 

Recently, even ET money conducted a similar study for the Indian Mutual Fund market and tracked the returns investors would make. As per the study, they tracked that if investors followed a buy and sell strategy with top rated mutual funds i.e. they bought the best fund and then sold them when their rankings fell, they would make a CAGR of 12.6% in the past 10 years (without accounting for the cost of investing, selling and taxation on the same). Now, instead of doing this, if the investor would have only invested in an index fund in the past 10 years (2010 to 2020), they would have made a return of 12.2%. 

 

The cost of transactions such as brokerage, exit load, STT and capital gains taxes (payable every time you book gains on mutual fund transactions) would further reduce your returns in case of a buy and sell strategy based on the top ranking fund. Also, it is not feasible to follow this approach once your portfolio grows too much.

 

Some learnings from the above 2 studies are as follows:

 

  1. Chasing past performance and looking out for best returns is a futile activity, it is not giving you better performances. It is only tiring you and keeping you away from focusing on important parameters.
  2. Invest as per your goals and risk profile, finalize the funds and stick to them. Rather than looking for quick gains, understanding wealth creation takes consistency and discipline is the way.
  3. If you want to learn on what parameters to check to select the right fund (please stop using the word best funds), check our blog  - Factors to check.
  4. If you really want to invest and make a financial plan - you can reach out to us by filling this google form or at iplan@wealthcafe.in We are SEBI registered investment advisors and can help you make sound investment decisions. You can read about our advisory services at ria.wealthcafe.in

 

Wealth Café Advice -  “Past performance is no guarantee of future results.” In search of looking for the best, you are missing on the right and the time a fund needs to create wealth and achieve your goals.

 

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

Mutual Funds - 11/23/2021

How long should you stay invested in mutual funds?

The struggle to stay committed to investments is as real as it is to stay committed to a human. How long your relationship with your mutual funds is a function of your need for that investment and your risk profile. 

 

Based on tenure of your goals

 

Invest based on your goal tenure: Investing is very simple if we understand all the rules. Goal based investing is based on the tenure of your goals.

  • Short term goals are less than 3 years goals.
  • Long term goals are more than 3 years goals

 

Invest in mutual funds by first identifying for which goal you are investing, what is the tenure of that goal and then invest till that goal is accomplished. Now where you invest to achieve that goal is a function of your risk profile. (we have discussed that here)

  • Short term goals are less than 3 years goals. - Debt Mutual Funds (short term)
  • Long term goals are more than 3 years goals - Mix of debt & Equity (as per your risk profile)

 

Invest in Equity for long term for higher gains and managed risk

 

Invest in equity for the long term to reduce the risk of investing in equity. Compound and grow your wealth and eventually achieve your long term goals. Lets understand how your long term goals will be achieved by investing in Equity. 

 

For instance, in 2010, if Rakhi had a goal of financing her child’s education and back then she knew that 12 years later i.e. in 2023 for her child’s Graduation, she would need around 1 crore for the same she would invest in the below mentioned manner (based on our recommendations)

 

From our savings calculator, you would have known that you need to invest INR 42,000 each month for the next 10 years (based on the assumption that you have a growth profile and would earn 12.6% returns from the same).

 

Now based on our investment plan - she would put 70% in equity and balance 30% in debt. Hence, from INR 30,000 if she invested 21,000 in Nippon India Growth Fund ( a mid cap Mutual Fund) each month for the past 10 years and stayed with the fund through all ups and downs, she would have made 17.10% return. Do note that when you are investing for a long term goal it will eventually turn into a short term goal and in the last 2 or 3 years remaining for the goal, you must shift your investments to debt and discontinue investing in Equity.

 

Hence, in case of Rakhi, she would invest in Nippon India Growth Fund till 2021 and then discontinue the same. For 2021, 2022, and 2023, she would invest the entire 30,000 INR in debt.

 

As per the returns, in 2021, she would have an equity corpus of INR 98.31 lakhs and a debt corpus of INR 21 lakhs. A total of INR 1.19 crores was accumulated in 2021. Given the goal is 2 years away, we advise Rakhi to gradually move her Equity exposure to debt to avoid any last minute volatility. Where the goal's value would have changed and Rakhi decides to continue her 30,000 investments, she can invest the same in Debt. 

(image from value research)

 

Please note that the context of this article is that you must invest for the long term in Equity only where your goal is long term. Over the long term, the risk of equity also reduces as we can see in the case of Nippon India Growth Fund from the image above. Long term investing results in higher gains due to compounding. Still people do not make returns, because they cannot stay committed to their mutual funds.

 

Do people actually stay invested for long term

Nippon India Growth Fund, launched in October 1995 as a mid-cap scheme, completed 26 years in October 2021 delivering a compound annual growth rate (CAGR) of 22.91%. Since launch, the fund has grown 207 times over. In other words, ₹1 lakh invested in the fund at the start would now be worth ₹2.07 crore.

However, according to data released by the fund house, only 2,600 investors have stayed with the fund since inception and their average assets under management (AUM) is a mere ₹5 lakh. In other words, this cohort of patient investors would have invested just ₹2,415 on average at the time when this fund was launched. (source of this data is from mint - https://www.livemint.com/mutual-fund/mf-news/nippon-amc-sheds-light-on-missing-mf-millionaires-11634232789297.html)

The effect of your money staying invested for longer is far more than getting in at the right time. Not many investors had stayed put for more than 15 years. Unfortunately, people try to time the market. The fund had been managed by various fund managers over time, and has weathered numerous economic events, including the dot com bust, the 2008 crisis, 2013 taper tantrum and covid in 2020.

Wealth Café Advise:

As investors, learn to be more disciplined and focused on the long term and do not get carried away by market volatility.

According to the study conducted by Axis Mutual Fund, four behavioral traits affect investors’ returns:

  • They overreact to market sentiment.
  • They focus too much on short-term market or fund performance.
  • They don’t follow an asset allocation strategy.
  • And, finally, they tend to invest haphazardly, rather than systematically.

 

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

Mutual Funds - 11/17/2021

Mutual Funds for a beginner - Your First Mutual Fund Investment?

Mutual Funds are one of the first investments that everyone wants to make. Reasons are very simple, it is super easy to invest in them and they are literally everywhere. Your uncle is recommending you the same, your friend has invested in it, even the influencers are talking about it. 

Many beginners get stuck with which mutual funds to invest in. There are over 2500 schemes across 44 AMC i.e. like there are over 4000 flavors available across 50 ice cream shops and one can only eat so much.

When it comes to ice cream, we all know that chocolate or candies are the standard safe bets that one can start with. Similarly in Mutual Funds, there are some categories which you can look at when you are a beginner. 

 

Before you start the process of Investing in Mutual Funds, check out the below 3 steps.

 

Step 1 - Understand what a Mutual Fund is - watch our YouTube video to know more about it.

Step 2 - Types of Mutual Funds and what do they mean - read our articles on this - Types of Mutual Fund

Step 3 - Know the basics of Investing your money that high risk = high returns and low risk = low returns. So when you are investing in Equity Mutual Funds, it sure does give you higher returns but has higher risks. On the other hand, when you invest in Debt Mutual Funds, it gives you lower returns but has lower risk. The only way to manage this high risk of equity to earn higher returns is to invest for a long  period of time (i.e. for more than 3 years) and stick to debt for short term investments. (Refer to the article to know how to invest your money based on your goals - Investment for children's higher education)

 

Mutual Funds to focus on as a beginner

 

Make your first investment in Debt Mutual Fund 

 

For the first time Mutual Fund investor, we would recommend going for a liquid mutual fund or an ultra short duration fund. These Mutual Funds basically invest in T-bills or short term debt investments with a maturity of not more than 90 days to 6 months. This ensures that there is liquidity and interest rate risk is minimized . Ensure that the underlying investment of the debt funds are all AAA rated to ensure your credit default risk is minimized. 

 

We recommend beginning with these funds as the risk is low and it will guide you to be more familiarized with the process of investing.

 

If you are skeptical of Equity, Invest in Hybrid Mutual Funds

 

Next investments you can try are Hybrid Mutual Funds such as Balanced Advantage Funds or Dynamic Asset Allocation Funds. These Mutual Funds primarily invest in a mix of debt and equity giving a balance of debt along with some growth exposure to equity. Do check the underlying portfolio mix of the Mutual Fund before you invest in them. For example, currently as of October 2021, ICICI prudential Balanced Advantage Fund has 60% in Equity and 40% in Debt. 

By Investing in a hybrid fund, you are not getting a 100% exposure to equity and it works good for you if you have never invested in equity and are skeptical to invest in it. By investing here, you will understand how volatile they can be and understand your risk tolerance better.

 

Going for Equity Mutual Funds as a beginner

 

Where you are comfortable with investing in Equity, you can try investing in either large cap mutual funds or index mutual funds. 

 

 Index fund is a mutual fund which invests in stocks which are a part of the indices that they track. The index can be the benchmark Nifty 50 index or it can be a small cap index or a sectoral Pharma Index.. There are index funds which track these indices and then change their allocation as per the changes in the index. Index Funds that track the Nifty 50 Index are a good starting point  as they give you exposure to the top 50 companies listed on the Indian Stock exchanges i.e. the large-cap companies. There is little to nil interference from the fund manager as they track the underlying index. Also, the expense ratio is lower compared to other actively managed funds. Hence, as a beginner a Nifty50 based index fund can be a good bet to begin with.

 

Large Cap Fund - These mutual funds select at least 80% stocks for investment from the largest 100 stocks listed in the Indian markets (highest market capitalization). These funds  may have higher expense ratios compared to Index funds as they are actively managed by the fund manager.  An actively managed fund attempts to beat the returns from an index fund by selecting stocks that the Manager expects will outperform. 

 

You can select between an active fund or a passive fund based on how you want your money to be managed.  

 

Useful, simple to understand and easy to execute. These should be the qualities of your first mutual fund. 

 

Wealth Café Advice:

Do not look at making quick returns by investing in mid or small cap mutual funds when you are a beginner. Start with large cap  mutual funds or hybrid mutual funds, understand them better, learn more about them and then allocate your money properly across other categories of Mutual Funds. You can start your investments in 2-3 Mutual Fund Schemes and build your portfolio over time. But be sure to keep a tab on the total numbers of Mutual Funds you own. Read our article - How many mutual funds to invest in to learn more about this.

 

To sum it up, your experience with your first fund will in many ways set the course for how you invest. This is why you do not want to overcomplicate the decision.

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

Mutual Funds - 11/16/2021

What are the differences between Mutual Funds and Smallcase investments?

As an investor if you want to invest in equity, you have 2 options- you either invest directly via stock market or through equity based mutual funds. A small case is a new and exciting product for retail investors that offers portfolio diversification as an in-built feature. 

 

What is a smallcase?

The new term ‘smallcase’ is something that is catching on with digitally savvy investors.

It is essentially a basket of stocks or ETFs, curated around a specific theme, or a specific investing style. For example Rising Rural Demand - Companies that stand to benefit from increasing rural consumption, IT Tracker-  Companies to efficiently track and invest in the IT sector, etc 

Under this platform, an investor can either create their own model investment portfolio, also termed as smallcase, or choose from the several existing ones which are created and managed by SEBI (Securities and Exchange Board of India) registered entities. All one needs to begin investing is a trading account and a demat account.

So again, back to the basic question, how is this any different from a mutual fund?

Smallcase portfolios often get compared with mutual funds. While the two are similar in that they both minimize risk through diversification, there are some of the prominent differences too.

Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.

 

Mutual Fund  Small Case
When you invest in a Mutual Fund, you buy units and not the individual stocks You buy the stock rather than units
Managed by mutual fund managers of the respective fund house  Managed by different entities including research firms, financial planners, etc
Predominantly have categorized based on fund size Smallcase portfolio is built on the theme or idea
Mutual funds have an  expense ratio The cost would vary from broker to broker. They can be a little on a higher side as compared to mutual funds.
Only the fund manager has the authority to update your fund and add or remove stocks Flexible as it allows you to update your smallcase portfolio and add or remove stocks
Some mutual funds preclude investors from exiting their investments for a certain period of time No lock-in periods
Some mutual funds preclude investors from exiting their investments for a certain period of time Needs a higher capital for investing. Since you are directly investing in shares, you will have to buy each unit of them, and to create diversification takes much of your capital
Mutual funds are managed by experts they have a lower risk Smallcase comes with a higher risk
There are some mutual funds that are termed ELSS (Equity Linked Saving Schemes) which can give you some tax benefits.  There is no tax benefit

 

Wealth Cafe Advice:

Mutual funds can be preferred for investors who are not from a financial background and want to give all the control to a third party to manage the money on their behalf.

Smallcase on the other hand can be useful for someone who’s with some financial intelligence and understands the technical jargon of the market

However, You need to have a long-term view towards investing if you want to put your money in smallcases.

Mutual Funds - 10/14/2021
Article Headers (20)-min

FMP? - Know everything about Fixed Maturity Plan

Many of us want to invest in instruments that are not very risky and generate good risk-free returns. Here comes the concept of investing in Fixed Maturity Plans (FMPs). 

What are FMPs?

These are closed-end debt funds, sold as if they were replacements for multi-year fixed deposits. The idea was:

  • You bought a fund
  • The fund bought some debt securities scheduled to mature in a certain period say 3 years.
  • After three years, the fund gave you back the maturity amount minus their fees and all that.

FMPs invest in commercial instruments, highly rated corporate bonds, and various money market instruments. The basic rule in the FMP is to park money in an instrument that has a similar maturity date.

Features of FMPs

  1. Fixed Maturity - The maturity period of an FMP is fixed and once you have invested through NFO (new fund offering), your investment is essentially locked in till maturity. The maturity period of FMPs is usually more than 3 years from the date of unit allocation. This ensures that indexation benefits can be obtained on FMP investments. Read more about indexation and capital gains here
  2. Reduced Interest Rate Risk - FMPs are least exposed to interest rate risk, as the fund holds instruments till maturity-getting a fixed rate of return. Interest rate risk indicates that whenever there is a change in the interest rate, the value of the underlying security and hence, the NAV of the fund would change (more or less) depending on the movement of interest. Locked-In Rates: While locked-in rates are an excellent choice during a falling interest rates regime, the same can become a problem during a period of rising interest rates. When market rates move upwards, locked-in rates can lead to missed opportunities concerning potentially higher returns coupled with possibly lower risk levels. You can learn more about it here -NM 104: Basics of Mutual Funds
  3. Low Liquidity - FMPs are not liquid, you cannot withdraw before the completion of full tenure. So, if you invest in an FMP of 3-year tenure, you can withdraw only after 3 years and not in between. 
  4. Lower tax liability - A majority of new FMPs feature a maturity period of 3 years or more. This ensures that long-term capital gains tax rules including indexation benefits apply to capital gains from these non-equity investments. Indexation provides investors with the benefit of factoring in inflation, which reduces overall tax liability on gains. Read more about mutual fund taxation rules
  5. Returns Not Guaranteed: Fixed Maturity Plans provide investors with the benefit of locked-in returns from instruments held till maturity and high-quality investments minimize the credit risk for investors. That said, the low potential risk does not mean zero risks for the investors, and returns from FMPs are still market-linked. As a result, returns from FMPs are not guaranteed unlike other fixed return instruments such as fixed deposits.
  6. Not similar to fixed deposit
    Comparison Criteria Fixed Maturity Plans Fixed Deposit
    Returns Market – Linked Returns Guaranteed Returns
    Taxation Capital Gains Taxation Rules apply to the  benefit of indexation Interest is taxed as per the Income Tax slab rate of the investor
    Liquidity Low Liquidity Premature withdrawal options and sweep-in fixed deposits make it very liquid.
    Maturity Options Varies for each scheme (typically 3-4 years) Varies by a bank (typically 7 days to 10 years)
  7. Banks waive penalties

On the other hand, an increasing number of banks are not levying any penalties on premature withdrawal of fixed deposits. The State Bank of India, for instance, does not charge any penalty on premature withdrawals from short-term deposits of Rs 15 lakh and above after seven days.

In cases of tenure of more than one year, there is a small penalty. The deposit earns 0.5% below the rate applicable for the period the money remained with the bank or 0.5% below the contracted rate, whichever is lower.

This makes bank FDs a better proposition for those in the lower tax brackets. The tax on FMPs will only be marginally lower and not make a significant difference for someone who earns less than Rs 5 lakh a year. Even though the tax will be higher on FDs, they will offer greater liquidity to the investor.

What are the things you must check before investing in an FMP?

While FMP offers several advantages over other fixed-income products, there are still certain factors that investors should keep in mind before taking the plunge. Here are a few of them.

  • Check Indicative portfolio:  If the indicative portfolio shows the portfolio will invest the majority of the corpus in bank certificates of deposits (CDs), then the portfolio may have lower risks compared to FMP’s which invest predominantly in Commercial Papers (CPs). Seen from the other side, having Commercial Papers in the portfolio may mean slightly higher rates. So as an investor before investing in an FMP you should have a clear idea about the risks you are willing to take and how does the portfolio looks like.
  • Credit rating of the securities:  You should also check the scheme’s offer document for the minimum credit rating of the securities the fund intends to invest in. The investors should also note that the higher the credit ratings of their securities, the lower the returns would be for the FMPs and vice versa. However, lower credit rating securities have higher credit risks; hence investors should keep in mind the same. Credit risk indicates the risk of default. 
  • Expense Ratio of the scheme – Investors should select a scheme that has a reasonable expense ratio as per the tenor of the FMP, as a higher expense ratio reduces the overall yield on the FMP.
  • Maturity of the Scheme: Some of the FMPs launched between January and March every year offer double-indexation benefits. Double Indexation helps reducing long term capital gains thereby reducing overall tax liability

TAXATION OF FMPS

As FMPs are a type of debt fund, they are taxed like other debt funds. Investments held for more than 36-months are taxed at the rate of 20%. But there is an indexation benefit available here. With indexation, you get to increase the purchase price of FMP units in accordance with the inflation during the period. This helps in reducing your taxable returns from FMPs. Do note that tax-saving FDs falling under 80C do not allow premature withdrawal. Where FMPs score over FDs is indexation benefit, which results in paying lower taxes.

 

Who Should Consider Fixed Maturity Plans?

Investors who are looking for higher returns in comparison to FDs and RDs and are willing to accept frequent market fluctuations can invest in FMP’s. Additionally, investors must be willing to lock in their funds for a time period of 3 years. In a bid to provide higher income to their investors, FMPs invest in instruments that bear some credit risk so ensure that you understand the risk when you invest in FMPs and do not invest in them as a replacement for fixed deposits.

Separately, for all your emergency funds - we would advise you to continue to invest in fixed deposits or liquid mutual funds. For short-term goals of up to 3 years - you can invest in short-term debt funds or could consider FMPs. But do remember that FMPs come with Fixed Tenure and hence, you cannot access it unless the tenure is completed.

 

Consult your financial advisor to understand how these funds fit into your risk appetite and goals. We are SEBI registered investment advisors and can help you make sound investment decisions - you can reach out to us at iplan@wealthcafe.in, in order to help you make a financial plan for yourself.

To learn more about Asset classes enroll in our course NM 103: Basics of Asset Classes

You can also check our course on Mutual Funds NM 104: Basics of Mutual Funds

Mutual Funds - 09/09/2021

When to exit from Mutual Funds or stop SIP?

One of the most common themes of discussion about Mutual Funds is – When it is a good time to invest? While answers to this question are readily available, a relatively less discussed theme is – When is a good time to exit your Mutual Fund investments? 

If you have been paying those SIP installments over a period of time, chances are that at some point, you would have asked yourself whether you should discontinue the payments.

So what are the triggers that should prompt you to exit from mutual funds or stop your SIP? In this blog, we will discuss specific instances of when you should consider exiting from your Mutual Fund investments and also how to come up with a viable exit strategy that works for you. 

Things To Know Before You Exit the Fund

It’s essential to choose your alternatives before you exit a fund. You need to ensure that the new fund is in sync with your needs. For instance, if you had invested in large-cap funds because they are less risky and find that your fund has now been merged with a mid-cap fund, then you can redeem the combined fund for a fund composed of pure large-cap units only.

Along with this, you also need to take the LTCG (Long-Term Capital Gains) tax into account and see to it that the exit and redemption do not cause you huge losses.

Know when to exit from investments in mutual funds

Sometimes even during your goal period, there might be instances demanding you to exit from investments. In such scenarios, exiting the investment is suggested only when:

  • When you achieve your financial goal

The basic reason you invest is to achieve your goals and if your goals are achieved or are at the stage where you need the money for the goal, you exit the fund. It is very simple right. However, your debt: equity allocation would tell a different story. If you had invested in a long-term goal say your kid's education of 15 years then you start exiting equity in the 12th year when it becomes a short-term goal and switch your money to liquid debt funds (safer options). From this debt fund, you redeem your units as and when you need money for the goal. Now after the 12th year you are sure that you will have money whenever you will need it for your child’s education. You no longer have to continue to invest after the 15th year. This is the most important reason or timing to exit the fund.

  • Consistent poor performance of the fund

If a scheme has underperformed consistently versus its category peers over the past several quarters, you should consider exiting the scheme in favor of a more consistent performer. There can be many reasons behind your fund’s dipping performance.

It might have taken exposure to an unsuitable sector or theme at an inappropriate time. In yet another case, your debt fund might have invested in low-credit-rated securities and failed to earn high returns as planned. 

Therefore, in order to gain the benefits, the mutual fund's investments should be tracked regularly. The performance of the mutual funds has to be seen in the right way. Following are some of the measures:-

  1. Compare your fund with the benchmark index
  2. Compare with the category average
  • Fund level changes are making you uncomfortable

This is quite a common problem. For example, the fund manager who was doing a wonderful job for the last 10 years may have moved on. Occasionally, the AMC gets sold to a new fund manager and you may be uncomfortable with the strategies of the fund. There are also occasions when the fund may have made some changes to the objectives of the fund or its asset mix which may be incongruent with your goals. These are again genuine cases for you to terminate your SIP or exit from the particular scheme. You can look for other funds that are consistent with your objectives.  

  • To Rebalance Your Investment Portfolio

Rebalancing and asset allocation are crucial parts of your investment strategy. 90% of your returns are determined from your rebalancing rather than the exact fund you invested in. For instance, when you started investing your asset allocation was 70:30 into equity and debt. After completion of one year, your target allocations might have skewed. It might be the result of the recent rally increasing NAV of the equity component of the portfolio.

Or, in another case, a macroeconomic policy shift may have made large-cap stocks more favorable over others. All of these would trigger a portfolio rebalancing. In this, you sell those funds which have become irrelevant in the current context. You invest that money in other funds which look more favorable. 

Ideally, SIPs should be investments in perpetuity. However, like all investments, one must review, re-balance and reset portfolios in line with current requirements and their risk appetite (which are always changing)

  • The fund is all over the media for the wrong reasons

Let us start with a caveat here! Not everything that appears on the media or social media needs to be entirely believed. They must be taken with a pinch of salt. But when you see consistent negative cues like SEBI investigations, penalties imposed, customer dissatisfaction, services issues, allegations of circular trading, etc, there is obvious room for worry. Random media reports are understandable. However, do your own research that if you find such news temporary and you have the risk of holding on, you could consider not selling. Just the media news cannot be a reason, otherwise, you will be changing your portfolio every 6 months.

  • There is an emergency

In case of financial emergencies, when your emergency fund isn’t sufficient to meet your requirement, you need to consider exiting your mutual fund investments. Therefore, funds should be parked in liquid funds for contingencies like emergencies.

 

If not for the above reasons, holding your investments for longer durations is always suggested. Along with an investment plan, always have an exit strategy ready for your investments. 

 

Always remember why you invested in a particular fund (and please may that not be ‘best funds of 2020’). Once you map your investments to your goals, these questions will not be very difficult for you to answer. As you exit when your goals are due or only when something gravely is wrong with the fund. Otherwise, it is Janam Janam ka Saath (especially in equity funds).

 

Hence, we always recommend learning about goal setting and investing properly to achieve your goals - check our course- NM 104: Basics of Mutual Funds

Mutual Funds - 08/26/2021

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